public debt crisis, austerity and deflation: the case of ... · public debt crisis, austerity and...

Public debt crisis, austerity and deflation:the case of Greece

Marica Frangakis*Nicos Poulantzas Institute, Athens, Greece**

Greece is the country in which the eurozone’s public debt crisis began in late 2009. Thepolicy response of the EU elites was to provide financial assistance on condition that astrict austerity-cum-deregulation policy is applied under the watchful guidance of theEuropean Commission, the European Central Bank and the IMF (the so-called Troika).Five years later, the country is in an economic, social and political limbo, as a debt-deflation process has set in. Greece, however, is not a special case. Rather, it illustratesthe failures of the prevailing economic and political orthodoxy in the EU. At best, it canserve as an example of the cost of ignoring the lessons of the 1930s Great Depression.

Keywords: austerity, eurozone crisis, public debt, deflation, depression

JEL codes: E310, E650, E660

1 INTRODUCTION

It is an observed fact that developments in economic thought tend to follow economicdevelopments. This is especially true of economic crises, which ‘can sometimes triggerenormous change, with regard to both economic theory and the politics of governance’(Palley et al. 2012, p. 1). For example, although under-consumption is an old conceptin economics going back to the sixteenth century, it was against the experience of the1929 Crash and the 1930s Great Depression that the economic and social implicationsof falling incomes and prices were discussed and new analytical tools conceived, chal-lenging the economic dogmas of the time and replacing them with a new corpus ofideas and principles. Unfortunately, the theoretical insights gained over the 1930sGreat Depression were lost sight of in the latter part of the twentieth century, as theprevalent paradigm shifted back to the orthodoxy which Fisher, Keynes and Kaleckihad challenged, to name but three thinkers of the time who made major contributionsto understanding the then prevailing economic, social and political conditions.

The misconceptions, gaps and weaknesses of present-day mainstream economicswere revealed by the 2007/2008 global financial crisis and the ensuing economic cri-sis. However, following the initial panic, economic policy reverted to the pre-crisisorthodoxy, thus ignoring the lessons of the 1930s. This is especially true of the EU,

* I would like to thank two anonymous referees for their valuable comments. Of course, allerrors remain mine.** Marica Frangakis is an independent researcher ([email protected]; http://academia.edu).She is a member of the Board of the Nicos Poulantzas Institute and a member of the SteeringCommittee of the EuroMemo Group (http://euromemo.eu).

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the response of which has been a combination of austerity and deregulation on the onehand, and financial policy reform at a snail’s pace on the other.

As a result, much intellectual energy needs to be spent on revisiting ideas andtheories developed against the background of the Great Depression and examiningtheir relevance today. It is in this spirit that the present article is written. Its objectiveis to examine the current Greek crisis through the lens of debt-deflation dynamicswithin the framework of EU economic policy.

The structure of the article is as follows. Section 2 discusses EU economic policyand its crisis response; the centrality of austerity is highlighted. Section 3 examines thepublic debt crisis in Greece under conditions of austerity, with reference to the debt-deflation mechanism. Section 4 is an epilogue, by way of summarizing andconcluding.

2 EU ECONOMIC POLICY AND CRISIS RESPONSE: FROM WAGE ANDPRICE RESTRAINT TO AUSTERITY

2.1 The framework of EU economic policy

Wage and price restraint is inherent in EU economic policy. The single currency edificerests on a narrowly defined range of fiscal indicators and an equally narrowly definedmonetary policy, focusing on inflation-targeting. The member states that do not belongto the eurozone emulate the benchmarks set for the latter. Thus, the differing levels ofproductivity, growth and employment across the EU member-states are by design out-side the core policy concerns. As a result, wages constitute the main adjustment mechan-ism in EU economic relations.

More specifically, the benchmarks set by the Stability and Growth Pact (SGP) limit thefiscal deficit to 3 per cent and the public debt to 60 per cent of GDP, while the EuropeanCentral Bank is entrusted with keeping inflation ‘below but close to 2 per cent’ and notlending to European public authorities of any kind, level, etc. The inefficiency of theeuro architecture became evident in the early 2000s and the dot.com bubble, whenthe SGP was violated by Germany and France among others, and declared ‘stupid’by the then President of the European Commission, Romano Prodi.1 As a result, certainaspects of the SGP were relaxed, although its essence remained intact.2

In the course of the 1990s and 2000s, the EU radically liberalized its financial sys-tem, promoting the integration of the financial markets with great enthusiasm. Infact, by the mid 2000s, the EU authorities boasted that the money market and thegovernment bond market were completely integrated.3 Some years later, both mar-kets seized up as the financial crisis migrated from the USA to Europe. Only thendid the implications of the lack of provisions, or indeed concern, for financial stab-ility become clear.4

1. http://www.telegraph.co.uk/finance/2830598/Euro-Stability-Pact-is-stupid-says-Prodi.html.2. For example, certain types of public expenditure might justify a ‘small overshoot’ of thelimit on the deficit/GDP ratio, while additional time may be allowed for the correction of anexcessive deficit when growth is slow. See Frangakis (2006) for an appraisal of the changesto the Stability and Growth Pact introduced in 2005.3. This is a claim regularly made in the annual Financial Integration Reports of the EuropeanCommission prior to the crisis.4. For a detailed critique of the EU financial integration policy, see Grahl (2009).

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Until that time, however, the increasingly financialized environment of the EUprovided the missing link in reconciling the different levels of productivity and com-petitiveness within the EU and especially the eurozone. The less competitive memberstates in terms of unit labour costs borrowed at a low interest rate from the financialinstitutions of the more competitive ones. The latter were happy to lend, as theirdomestic market did not provide an adequate outlet. Thus, the export-led model ofthe largely Northern European countries was combined with the debt-led model ofthe mainly Southern European countries to produce the imbalances that later becameevident (Stockhammer 2012).

This happy state of affairs lasted until the outbreak of the crisis; that is, until the late2000s. The imbalances upon which the single currency rested became only too clear,as the financial crisis fed into an economic crisis, which in turn inflated the public def-icit and debt of the EU member states. Although this chain of events is historicallyfamiliar, given the record of capitalist crises, it caught the EU authorities unawaresand unprepared to deal with it. However, as the early panic of the financial crisis sub-sided, the EU authorities declared the crisis at an end in early 2009 and reverted to themain tenets of the pre-crisis economic policy, with an added twist. The contractionaryfiscal policy of the SGP became even more so. Austerity had arrived in Europe. Thiswas entrenched in new fiscal policy measures, as well as in the ‘Economic AdjustmentProgrammes’ signed by indebted member states, such as Greece.

In particular, the revised EU fiscal policy rules introduced more stringent require-ments, sanctions and procedures.5 For example, a new benchmark limits public expen-diture growth to that of potential GDP, which is however not an observable variable;public debt in excess of the 60 per cent of GDP limit must be reduced at a rate of1/20th per year; sanctions are imposed automatically unless a qualified majority inthe Council votes against them (reverse qualified majority voting); the observance ofthe EU fiscal policy framework is monitored through enhanced surveillance rules,while the European Court of Justice may impose a financial sanction (0.1 per cent ofGDP) on a member state, if it fails to transpose the new fiscal rules in national lawthrough preferably constitutional provisions.

By contrast, financial policy reform, deemed necessary in the aftermath of the cri-sis, is proceeding in a slow, piecemeal fashion, while major issues such as the size andinterconnectedness of the EU financial institutions are not addressed. In this way, theinefficiency and class bias inherent in the EU economic policy framework wereextended to its crisis response. Furthermore, they were compounded by the theoreticalmisconception of the crisis and the ideological bias of the economically and politicallystrongest member state, Germany, against inflation.

2.2 Austerity: theory and morality

The response of the EU to the financial crisis was to provide generous, unconditionalsupport to its banks. Over the period 2008–2012, approximately 40 per cent of EUGDP was devoted to rescuing the financial system (European Commission 2012).Such rescues were in blatant violation of the no-bail-out clause of the 2005

5. The post-crisis EU fiscal framework comprises, in addition to the SGP, the so-called ‘sixpack’ (five regulations and one directive), the ‘two pack’ (two regulations) and the Fiscal Com-pact, which is contained in the intergovernmental Treaty on Stability, Coordination andGovernance.

Public debt crisis, austerity and deflation: the case of Greece 297



Memorandum of Understanding on crisis management in the EU financial sector, aswell as of the EU competition policy more generally.6

Furthermore, the support extended to the banks was financed from the member states’individual budgets, thus exacerbating the effect of the crisis on public finances. As mightbe expected, this led to increased public deficits and debt across the EU, which alertedthe EU authorities. Accordingly, the narrative of the crisis advanced by the EU elitesshifted from finance to fiscal profligacy and lack of competitiveness, thus deflectingthe pressure for financial reform and redirecting public anger about the crisis againstparticular countries and governments. This narrative justified the ever-tighter fiscalpolicy implemented both on the EU level and in individual member states, thus provid-ing the theoretical underpinning and moral basis for the EU austerity-led crisis response.However, it is problematic both in theoretical and in moral terms.

Theoretically, relying on generalized austerity to deal with a recession commits theerror of the fallacy of composition, which is tantamount to overlooking the Keynesiansavings paradox. In particular, whereas a household may well wish to reduce its debtexposure during a recession, the same cannot be said of the aggregate of households,far less of the government. Indeed, if all households reduce their consumption in orderto pay off their debts, the government needs to make up the fall in demand by increasingits own spending, so as to avoid the recession becoming deeper. Thus, ignoring theKeynesian savings paradox implies that increasing aggregate savings in a recession isharmful for the economy. However, this is precisely what generalized austerity is about!

The moral basis of the EU austerity drive goes even further, insofar as it draws a par-allel between those residing in Southern Europe and the proverbial ‘Swabian housewife’(Schwäbische Hausfrau), who manages her household with prudence, setting an exam-ple for others. For example, Wolfgang Schauble, Germany’s federal minister of finance,has stated in plain terms that austerity is the ‘only cure for the eurozone’. In particular,

the recipe is as simple as it is hard to implement in practice; western democracies and othercountries faced with high levels of debt and deficits need to cut expenditures, increase rev-enues and remove the structural hindrances in their economies, however politically painful.(Schauble 2011)

Analytically, the moral basis of austerity conveniently ignores the fact that in a monetaryunion, competitiveness is a relative notion. If all member states restrain wages at the sametime, the result will be a ‘beggar thy neighbour’ race to the bottom and a frantic search forexport markets. After all, in the early 2000s Germany was able to restore its competitive-ness by repressing wages while the other eurozone member states provided the spendingpower that supported German exports. However, in the present crisis, Germany is notwilling to reciprocate, preferring instead a competitive wage-price process. The explan-ation for Germany’s stance lies also in its ideological bias against inflation, in spite of thefact that the country has known painful bouts of deflation in the not too distant past.7

6. The 2005 MoU includes arrangements for the development of contingency plans for themanagement of crisis situations, along with stress-testing and simulation exercises and an expli-cit statement that it should not be construed as representing an exception to (i) the principle ofthe firm’s owners’/shareholders’ primary financial responsibility; (ii) the need for creditor vig-ilance; and (iii) the primacy of market-led solutions when it comes to solving crisis situations inindividual institutions.7. A similar moralistic stand was taken during the 1930s Great Depression by the ‘liquidation-ists’; that is, those supporting the liquidation of large segments of the economy in the name ofthe revitalization of the productive forces, which included Friedrich Hayek, Lionel Robbins andJoseph Schumpeter.




Overall, the theoretically fallacious and the morally/ideologically biased under-standing of the crisis is weakening the eurozone and the EU more generally, as growthremains subdued, turning negative in certain areas, while unemployment has reached ahistoric high. For example, in 2013, real GDP was stagnant in the EU on average(0.0 per cent) and it declined in the eurozone (–0.5 per cent), while in 10 out of28 countries of which 8 belong to the eurozone, it registered negative values (EuropeanCommission 2014). In 2013, unemployment reached 10.8 per cent of the labour forcein the EU on average and 11.9 per cent in the eurozone, while in 9 countries it wassignificantly greater than average (from 14.2 per cent in Slovakia to 27.5 per centin Greece). Furthermore, the rate of inflation was very low in most countries in2013, while it is estimated to have turned negative in 2014. In particular, in 2013 infla-tion was equal to 1.5 per cent in the EU on average and 1.4 per cent in the eurozone,expected to slip down to 0.6 per cent and 0.5 per cent respectively in 2014, while nega-tive values were registered in Greece (–0.9 per cent in 2013 and –1 per cent in 2014),Spain (1.5 per cent and –0.1 per cent), Cyprus (0.4 per cent and –0.2 per cent),Slovakia (1.5 per cent and –0.1 per cent) and Bulgaria (0.4 per cent and –1.4 per cent).Disinflation and deflation appear to have set in throughout the EU and especially inCentral and Southern Europe.

2.3 Monetary policy and austerity

As the sole objective of the European Central Bank is that of maintaining inflation ‘belowbut close to 2 per cent’, it has had to improvise since the early stages of the financialcrisis in order to prevent the monetary transmission mechanism from breaking downas the interbank market seized up in late 2007. Such unconventional measures haveincluded purchases of limited amounts of government bonds in the secondary market(Securities Market Programme 2010/2011), relaxing the rules on collateral, providinglong-term financing to the banking sector under the ECB’s Long Term RefinancingOperations (LTRO 2011 to present) and its Targeted LTRO (2014–2018), reducingits main refinancing operations rate to 0.05 per cent in September 2014, a historiclow, announcing its intention to do ‘whatever it takes’ to stem financial speculation inthe secondary government bond market (Outright Monetary Transactions, 2012) andeventually undertaking quantitative easing, or an ‘expanded asset purchase’ programme,encompassing the existing purchase programmes for asset-backed securities and coveredbonds (January 2015). In particular, the ECB will buy bonds issued by eurozone govern-ments, agencies and European institutions in the secondary market against central bankmoney. The combined monthly asset purchases are targeted at €60 billion, to be carriedout until at least September 2016.

It is worth noting that the ECB’s assistance – including its latest ‘bazooka’ – hasbeen mainly addressed to the European banking sector, while that addressed to theeurozone governments via the secondary bond market is conditional on the implemen-tation of austerity measures. Schiaffino calls this the ‘ECB solution … [which is]designed to save every euro from households, firms and government and reassign itto debt payments’ (Schiaffino 2013, p. 460).

Thus, while the ECB has periodically eased liquidity pressures, it has not deviatedfrom the central EU policy line of austerity in dealing with the crisis. Not surprisingly,its escalating monetary policy offensive has so far failed to stop the slide of the eurozoneinto stagnation, nor of the average inflation rate to below 2 per cent. Furthermore, theECB is running out of options, in view of the fact that further reductions in its lendingrate are bound to be ineffective, as this is already close to the zero bound.




3 THE CASE OF GREECE

3.1 Revisiting debt-deflation depression: some theoretical considerations

In this section, we discuss certain elements of the theory of debt-deflation, which weconsider as essential for the understanding of the forces at work in the Greek case. Theterm was popularized by Irving Fisher, who put forward the ‘Debt-Deflation Theory ofthe Great Depression’ in a seminal 1933 article (Fisher 1933). He focused on the finan-cial crash, the devastating effects of a downward spiral linking the fall in assets and ingoods prices, the process of deleveraging by households and firms and the ensuingcontraction of economic activity with its disastrous social effects. The chain of conse-quences of a debt-deflation dynamic process is as follows:

• Declining prices give rise to expectations of a further drop. This provides con-sumers with the incentive to postpone purchases. As a result, aggregate demandfalls, putting further downward pressure on prices. Also, the foreign-exchangevalue of the currency hardens, thus exacerbating the situation via the tradechannel.

• Since public and private debts are fixed nominally, declining prices increasetheir real value. This induces households and businesses to reduce their con-sumption of goods and services in order to spend a higher proportion of theirincome on servicing their debt. To the extent that the government emulateshousehold behaviour, the debt-deflation downward spiral is intensified.

• Furthermore, households and businesses are driven to distress selling in order toservice their debts, thus driving asset prices down. Where a government opts forthe privatization of public assets in order to repay its creditors, it adds to thedownward pressure on asset prices.

• The greater the decline in asset prices, the greater the fall in the net worth ofbusinesses, precipitating bankruptcies. Together with the drop in aggregatedemand, this leads to a decline in profit and a reduction in output andemployment.

• Pessimism and loss of confidence become the order of the day, leading to thehoarding of cash.

• Under these circumstances, while nominal interest rates decline, real interestrates rise, impeding the overcoming of the debt-deflation dynamics.

In observing this chain of events, Fisher noted a ‘great paradox’, whereby ‘the morethe debtors pay, the more they owe’ (ibid., p. 344). Hence, Fisher concluded that the‘natural’ way out of deflation propagated by the conventional wisdom of his time was‘via needless and cruel bankruptcy, unemployment and starvation’ (ibid., p. 346). Herejected this prospect, arguing that ‘great depressions are curable and preventablethrough reflation and stabilisation’ (ibid., p. 350).

Fisher’s ‘great paradox’ echoes Keynes’s ‘savings paradox’, whereby8

although the amount of (an individual’s) own saving is unlikely to have any significant influ-ence on his own income, the reactions of the amount of his consumption on the incomes ofothers makes it impossible for all individuals simultaneously to save any given sums. Everysuch attempt to save more by reducing consumption will so affect incomes that the attemptnecessarily defeats itself. (Keynes 1936 [2003], ch. 7, p. 84).

8. This is tantamount to the ‘fallacy of composition’, which holds that what is true of the partsmust be true of the whole.




The deleterious effects of the debt-deflation process were explicitly recognized byKeynes, who, in discussing the Great Slump of 1930, noted the following:

Thus neither the restriction of output nor the reduction of wages serves in itself to restoreequilibrium … every fall of prices increases the burden of this [post-World War I] debt,because it increases the value of the money in which it is fixed … In such a situation itmust be doubtful whether the necessary adjustments could be made in time to prevent a seriesof bankruptcies, defaults, and repudiations which would shake the capitalist order to its foun-dations. (Keynes 1930 [2008], pp. 1 and 2)

Keynes’s key insight was that a market-based, capitalist economy does not possess aself-adjusting mechanism to bring it back to full employment after a negative econ-omic shock. On the contrary, such an economy may remain in a persistent underem-ployment equilibrium, giving rise to negative expectations, or ‘animal spirits’, and to alack of demand for credit, associated with the deleveraging of the private sector. Thiseffectively means that conventional monetary policy measures, such as a reduction inshort-term interest rates, do not work. What does? Keynes’s answer to this questionwas a fiscal expansion in aggregate demand through higher government spendingand lower direct taxation in order to boost household disposable income.

As we shall see, the Greek crisis has its own particular characteristics, extensivelyentangled with those of the eurozone construction. However, what distinguishes thepublic debt crisis in Greece, and indeed in the eurozone, is the fact that the fiscal policyapplied goes in the opposite direction to that recommended by such students of the GreatDepression as Fisher and Keynes. Austerity, via fiscal consolidation, deregulation andprivatization, is the overarching principle of current EU economic policy vis-à-visindebted countries, such as Greece, as well as on the EU level.

Michal Kalecki’s economic and political pragmatism points to a possible reconci-liation of this modern-day paradox. In his seminal 1943 article, Kalecki pointed outthat a state of permanently high employment would alter power equilibrium withinsociety. However,

[i]n this situation a powerful block is likely to be formed between big business and rentierinterests ... The pressure of all these forces and in particular of big business – as a rule influ-ential in Government departments – would most probably induce the Government to return tothe orthodox policy of cutting down the budget deficit. (Kalecki 1943, p. 330)

By analogy, it may be argued that the current ‘powerful bloc’ in the EU, consisting oflarge, interconnected corporations both in the productive and in the financial sectors, istrying to strengthen its post-crisis position via austerity, even if this means increaseddamage for themselves at least in the short-run.

3.2 Greece: from high growth to near insolvency

Greece, in contrast to many other European countries, did not experience a financialcrisis per se. As the financial crisis filtered through to the economy, however, Greecefelt the effects of the economic crisis; that is, a decline in output and an increase inunemployment – signs of the oncoming recession – as well as a worsening of its publicfinances, as the automatic stabilizers came into play.

At the start of the crisis, Greece displayed high public and current-account deficitsin relation to GDP, partly explained by the country’s high growth rate prior to the crisisand partly by its mode of capitalist formation.




As shown in Table 1, Greece was a high-performing economy after joining theeurozone and prior to the crisis. Its boom, however, was mainly driven by largelydebt-financed domestic demand (public and private). The prevailing low interestrate in the eurozone and the financial deregulation of the EU provided Greece withthe means to finance its debt and its current-account deficit. Greece, like Spain andother Southern European states, grew at a faster rate than (for example) Germany,thus providing an outlet for German exports and finance at a time when wage repres-sion in Germany limited domestic demand for goods and services, as well as for loans.

The high public deficit and debt, as well as current account deficit of Greece, arefurther explained by the country’s capitalist formation. More specifically, followinga devastating WWII and a destructive civil war (1944–1949), the Greek economywas in a state of collapse. The period 1950–1973 was dominated by the authoritarianRight (1950–1967) and the dictatorship (1967–1973). During this period, economicpolicy aimed at ‘growth at any cost’, on the basis of a ‘social compromise’, which tol-erated tax digressions and favourable tax arrangements for the industrial and the ship-ping sectors, exemption of farmers from income tax, tax evasion by small businessesand professionals, etc. (Stathakis 2010).

The start of the welfare state goes back to the 1980s. Having just joined theEuropean Common Market, Greece underwent a process of deindustrialization. As aresult, a number of former national champions were nationalized, with the state takingover their liabilities. The problems facing the economy were compounded by sluggishgrowth and high inflation, resulting in a severe worsening of public finances. Duringthe period 1950–2010, the question of the elimination of tax evasion remained outsidethe political agenda. This is a salient feature of the chronic fiscal problems of Greece.

Other features of the Greek economy can be explained by taking a longer-term viewof the development of capitalism. For example, the existence of ‘closed professions’and high public-sector employment denote the attempts of capitalists to tie in the

Table 1 Profiling the Greek economy, 2002–2006 (percentage annual change unlessotherwise stated; ranking)

EU27 EU17 Greece Ranking inEU27; EU17

Growth rate 2.1 1.8 4.3 9th; 4thGrowth rate per capita 1.7 1.2 3.9 11th; 4thDomestic demand growth 2.1 1.7 4.1 8th; 5thHICP 2.3 2.2 3.4 6th; 3rdEmployment 0.6 0.7 1.7 8th; 6thUnemployment (% of labour force) 8.9 8.8 9.9 6th; 3rdLabour productivity (real GDP per occupied person) 2.0 1.1 2.6 11th; 4thReal LUC −1.0 −0.7 −0.1 9th; 5thTotal gen. government expenditure (% GDP) 46.7 47.4 45.2 12th; 9thTotal gen. government revenue (% GDP) 44.2 44.8 39.3 16th; 12thInterest expenditure (% GDP) 2.9 3.1 4.9 2nd; 2ndPublic deficit cyclically adjusted (% GDP) −2.8 −2.7 −6.0 2nd; 1stPublic debt 2006 (% GDP) 46.3 52.9 103.4 1stPrivate debt 2006 (% GDP) 123.9 140.5 93.0 16th; 16thCurrent-account balance (% GDP) 0.1 0.6 −11.9 3rd; 2nd

Sources: European Commission (2011), European Economic Forecast, Autumn and Statistical Annex ofEuropean Economy, Autumn; Eurostat.




interests of the middle class and sections of the working class to their own. In thissense, the resulting social and economic configuration is a component rather than asymptom of contemporary Greece.9

In the wake of the financial crisis, Greek government bonds came under increasingpressure in the financial markets. By April 2010, the spread between the yields on10-year Greek government bonds and German bunds became untenable, as shownin Figure 1.

At that point, the available options were:

• Restructuring the Greek public debt. This was indeed quite small by comparisonto that of other eurozone member states.10 According to the IMF, this option wasdiscussed and rejected by the EU leaders, who feared a possible contagion; thatis, an increase in the yields of other Southern European countries’ governmentbonds (IMF 2013). In 2012 the Greek public debt was restructured, albeitthrough new borrowing.

• The ECB buying up Greek government bonds, as other central banks did at thattime vis-à-vis their respective governments. As this is not allowed by theTreaty, the second-best option for the ECB would have been to declare thatit was prepared to do ‘whatever it takes’. This it did not do until the summerof 2012, when Spain found itself under speculative pressure in the financialmarkets.

• Greece borrowing from its eurozone partners in order to repay its creditors, thatis, the European banks. This is indeed what happened. Two loans were con-tracted in 2010 and 2012, amounting to a total of €237 billion, conditional onthe implementation of a severe fiscal austerity programme, combined withderegulation and the privatization of public assets and services on a grandscale. Of this amount, more than 80 per cent was channelled back to theEuropean and Greek banks, largely through an over-generous debt restructuringplan (Zettelmeyer et al. 2013).

1000

800

600

400

200

98 99 00 01 02 03 04 05 06 07 08 09

Stabilization programme announced

Revision of 2009 deficit

Lehman Brothers failure

Bear Stearns rescue

US subprime mortgage crisis

100

Source: Gibson et al. (2011).

Figure 1 10-year government bond spreads between Greece and Germany

9. See Frangakis (2011) for an account of the Greek public debt crisis.10. For example, in 2009 it was equal to 5.9 per cent of the combined public debt of France,Germany and Italy (Eurostat annual data).




3.3 The Troika prescription

The austerity measures prescribed by the triumvirate of the European Commission, theEuropean Central Bank and the IMF (alias the Troika) include the following:

• Fiscal consolidation Over the period 2010–2014, fiscal austerity measuresamounted to over 30 per cent of GDP, more than half of which (54 per cent)is expected to derive from expenditure cuts and the remainder (46 per cent)from increases in revenue, although only 3 per cent of GDP is to comefrom improving tax compliance. Public sector employment is being reducedby 23 per cent, while further cuts in spending include education (primaryand secondary schools are closed down or merged), health care (hospitalunits are closed down or privatized, etc.), cash welfare benefits, pensionsand social transfers.

• Labour market reforms These aim at reducing the cost of labour via internaldevaluation. Thus the minimum wage has been reduced by 22 per cent, andby 32 per cent for the under-25s; collective agreements have been suspended,to be replaced by firm-level agreements; dismissals have been made easier;social contributions have been reduced; life tenure contracts have been abol-ished. As a result, flexible types of employment are on the rise, even thoughtotal employment has been declining. For example, between 2009 and 2013new hirings declined by 50 per cent, while part-time and temporary hiringsincreased by more than 50 per cent (INE-GSEE 2013).

• Structural changes These include a far-reaching privatization programme andthe deregulation of the transport sector (road haulage), energy (granting accessto 40 per cent of lignite-fired capacity before the Public Power Corporation isprivatized), the regulated professions (lawyers, public notaries, pharmacists,doctors, etc.), the judicial system and the pension system.

3.4 From recession to depression

The Troika prescription intensified the implications of the economic crisis, already dis-cernible in 2009. In effect, it signalled the start of a process of debt-deflation depres-sion of the type experienced in the 1930s. In this section, we shall attempt todisentangle the different aspects of this process and to identify the relevant chain ofconsequences.

Disinflation and deflation

The starting point of a debt-deflation is declining prices. Indeed, in Greece, the lossof confidence in the economy led initially to disinflation and, as of late 2012, todeflation. More specifically, the Harmonised Consumer Price Index (HCPI) sloweddown from 4.2 per cent in 2008 to 1 per cent in 2012, becoming negative (–0.9 percent) in 2013 (Table 2). This downward trend becomes even clearer when energy andseasonal food prices are excluded from the HCPI, which bottomed out at 0 per centin 2012 and fell to –1.8 per cent in 2013, while the GDP deflator was negative bothin 2012 (–0.3 per cent) and in 2013 (–2.1 per cent). On the other hand, the priceincreases observed in 2010 and 2011 were mostly due to the rise in the rate of




Value Added Tax from 19 per cent to 23 per cent as well as the shifting of manygoods and services to a higher-rate bracket.11

A disinflationary process is also present in the eurozone on average, although in amilder form, as the HCPI slowed down from 3.3 per cent in 2008 to 1.4 per cent in2013 as shown in Table 2. Furthermore, the euro currency hardened vis-à-vis thatof the EU’s main trading partners in the wake of the global financial crisis, thus exacer-bating the deflationary dynamics.12

Consumption and investment

As discussed in Section 3.2, prior to the crisis Greece had the highest public debt inrelation to GDP, although its ranking with regard to private debt was much lower(Table 1). Thus the decline in prices increased the real value of the debt burden (bothpublic and private). This led households and businesses to reduce their consumptionin order to service their debt obligations. Thus, household consumption declined by4 per cent between 2007 and 2010 and a further 21 per cent between 2010 and 2013,while Gross Fixed Capital Formation fell by 37.2 per cent and 43.6 per cent respectively(Figure 2). At the same time, government consumption was reduced by 6.7 per cent and15.3 per cent, while government investment declined by 27 per cent and 32 per centrespectively. In other words, faced with the crisis, government policy became highlypro-cyclical. For example, between 2007/2008 and 2012/2013 real public social spend-ing in Greece was reduced by 18 per cent as opposed to an increase of 14 per cent in theOECD and 11 per cent in the EU on average (OECD 2014a).

Furthermore, government revenue was increased mainly through a rise in con-sumption taxes, the share of which rose from 36.6 per cent of total taxation in2007 to 38.5 per cent in 2011, far higher than the eurozone average of 27.4 per cent.

Financial distress

Heightened pressure leads to financial distress and to distress selling. Telling signs ofsuch distress have been the rapid and continuous fall in asset prices. In particular, theHouse Price Index has been following an inverse trend in relation to the eurozone aver-age since late 2009, as shown in Figure 3.

Table 2 Average annual rate of change HCPI (all items) in Greece and the eurozone

2007 2008 2009 2010 2011 2012 2013

Eurozone 2.1 3.3 0.3 1.6 2.7 2.5 1.4Greece 3.0 4.2 1.3 4.7 3.1 1.0 –0.9

Source: Eurostat, accessed 21–27 April 2014.

11. The standard VAT rate applied in Greece is 23 per cent and the reduced rate 6.5–13 percent. Greece has one of the highest rates of VAT in the EU, the second-highest gas/petroltax, and the fifth-highest VAT rate on alcohol.12. For a comprehensive account of the oscillations of the euro exchange rate, see https://www.ecb.europa.eu/stats/exchange/effective/html/index.en.html.




https://www.ecb.europa.eu/stats/exchange/effective/html/index.en.html

https://www.ecb.europa.eu/stats/exchange/effective/html/index.en.html

The Athens Stock Exchange has also registered steeply declining asset prices. Inparticular, the ASE Index averaged 1892.83 points from 1987 to 2014, reaching anall-time high of 6.355.04 points in September 1999, dropping to as low as 1032.98points in December 2014.13

The mammoth privatization plan initially included in Greece’s Economic Adjust-ment Programme would have applied even greater pressure on asset prices. The rateof implementation of the plan however has been relatively slow, hinting at possibleexpectations of further asset price declines.

Bankruptcies

The decline in asset prices leads to bankruptcies as the net worth of businesses isreduced. Indeed, between 2008 and 2013, 37 per cent of all Greek enterprises closed

160000.0140000.0120000.0100000.080 000.060 000.040 000.020 000.0

0.02000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Household consumption Government consumption GFCF


Figure 2 GDP components (million euro; 2005 prices)

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Figure 3 House price index – quarterly data, annual rate of change (%)

13. http://www.tradingeconomics.com/greece/stock-market (accessed 6/12/2014).




http://www.tradingeconomics.com/greece/stock-market

down, underlining the severe distress experienced by the Greek economy (EuropeanCommission 2013). It should be noted that the vast majority of Greek enterprisesare small units (with fewer than 50 employees and mostly family-run), and thesewere hit especially hard (Table 3).

Large, long-established firms have also met with extreme financial difficulties. Forexample, Nutriart ABEE – created in 2008 from the merger of three of the largest com-panies in the Greek food industry (Katselis, Allatini and Elvipet) – declared bankruptcyin 2013. Similarly, Greece’s biggest furniture company, NEOSET, with a network of100 stores and 1014 employees, declared bankruptcy in 2012, as did another well-known Greek furniture manufacturer, SATO.14

Wages, labour unit costs and gross operating surplus

The combination of bankruptcies and the drop in aggregate demand has led to a pro-nounced fall in the wage bill. Between 2008 and 2013, the total compensationof employees declined by 7 per cent on average, while the share of wages in GDPfell from 51.5 per cent in 2006 to 48.8 per cent in 2013, thus returning to its levelof the mid 1990s.15 Over the same period, gross operating surplus also declined by3.4 per cent on average, although its share in GDP increased.

As a result, labour unit costs declined steeply in Greece in relation to the eurozone(Figure 4). This is a central objective of the Troika prescription. However, to the extentthat the same recipe is followed by all the eurozone member states, its implications forGreek exports are mitigated.

Output and employment

Between 2007 and 2013, domestic demand declined by 32 per cent. During the sameperiod, exports also declined (by 13 per cent), as did imports (by 43 per cent). Thus,

Table 3 Greek SMEs (no of enterprises, million euro GVA, persons employed)

2008 2013Enterprises by no ofemployees

No ofenterprises

GVA No of personsemployed

No ofenterprises

GVA No of personsemployed

0–9 213 827 5 895 419 600 134 758 4 912 266 43610–49 6 778 3 805 142 890 3 936 2 440 80 27450–249 1 176 4 404 118 250 835 3 173 83 409250+ 165 7 860 100 286 120 5 845 71 365Total 221 946 21 964 781 026 139 649 16 369 501 484

Note: GVA = Gross Value Added.Source: European Commission, Annual Report on European SMEs 2012/2013; database.

14. ‘One of the largest companies in the food industry declares bankruptcy’, 26 June 2013,http://www.grreporter.info, accessed 24 April 2014; ‘Greece’s biggest furniture company NEO-SET files for bankruptcy’, 12 November 2011, http://www.keeptalkinggreece.com, accessed24 April 2014.15. Compensation per employee as a percentage of GDP at market prices per person employed(AMECO, latest update 5 February 2015).




http://www.grreporter.info

http://www.keeptalkinggreece.com

although the current-account balance was improved, the gap in domestic demand wasnot made good.

In fact, output took a deep plunge, far greater than the eurozone average, which isalso struggling with a deteriorating growth rate, as shown in Figure 5. In particular,over the period 2007–2013, GDP in Greece declined by nearly 25 per cent in realterms.

Equally striking is the steep rise in the rate of unemployment in Greece, which morethan trebled, reaching 27.6 per cent of the labour force in 2013 from 8.3 per cent in2007. Over the same period, unemployment in the eurozone increased from 7.5 percent of the labour force in 2007 to 12 per cent in 2013 on average. It is worth notingthat unemployment in Greece, as indeed in the EU, has hit female workers and theunder-25s especially hard, while long-term unemployment has skyrocketed. For exam-ple, 31.6 per cent of female workers and 65 per cent of under-25s were unemployed in2013, compared to 12.1 per cent and 24 per cent respectively in the eurozone. Further-more, more than one-third of the unemployed have been without a job for over 1 year.

The social implications of the economic decline signify a rupture in social cohesion.More specifically, between 2007 and 2011, the fall in the disposable income per

10.0

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Figure 4 Real labour unit cost, percentage change on previous period

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

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Figure 5 GDP at market prices, percentage change on previous year (2005 prices)




household in Greece was the highest among the 33 member states of the OECD,amounting to 8.3 per cent as opposed to an average fall of 0.50 per cent in theOECD-33 countries (OECD 2014b). Such a decline resulted in greater inequalityand poverty, as it hit lower incomes especially hard. For example, in 2012,34.6 per cent of the population was at risk of poverty or social exclusion, comparedto 24.8 per cent in the EU and 23.3 per cent in the eurozone.16

Money supply and interest rates

As pessimism and loss of confidence became entrenched in the Greek economy andsociety, the hoarding of cash became evident. Thus, by 2012, the sum of total deposits(all types) and currency in circulation (approximating M2) dropped by 25 per cent inrelation to 2008, providing a further measure of the collapse of the Greek economy.17

Furthermore, bank loans declined by 18 per cent between 2008 and 2012.18 On theother hand, nominal interest rates for long-term and short-term lending to non-financialcorporations have not declined substantially, oscillating around the 5–6 per centmark.19

Debt

Although the public deficit declined from 15.2 per cent of GDP in 2009 to 1.6 per centin 2014, the public debt of Greece has increased both in absolute and in relative terms,as shown in Table 4.20

This was the outcome of the loans granted to Greece in 2010 and 2012 and the pro-cyclical austerity policy resulting in the steep contraction of GDP. Not surprisingly, theinterest payments paid by Greece to its creditors are much higher than in the EU onaverage. For example, in 2012 these amounted to 5 per cent of GDP (2012) as opposedto 2.9 per cent in the EU and to 3 per cent in the eurozone.21

Table 4 Public debt of Greece 2007–2013

2007 2008 2009 2010 2011 2012 2013

Euros, billion 239.5 263.3 299.7 329.5 355.1 303.9 322.2Per cent GDP 107.3 112.9 129.7 148.3 170.3 156.9 176.2


16. http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/People_at_risk_of_poverty_or_social_exclusion.17. IMF International Financial Statistics: euro millions, national residency, 34AZK + 34ZK +35ZK.18. Outstanding amounts of loans and receivables at end period: consolidated banking data,ECB Statistical Data Warehouse.19. ECB Statistical Data Warehouse, Monetary and Financial Statistics.20. Excluding interest payments turns a deficit of 10.2 per cent of GDP in 2009 to a govern-ment surplus equal to 2.7 per cent of GDP in 2014.21. The Troika loans were granted on commercial terms. For example, the interest rate on the2010 loan amounted to 5 per cent p.a. This was reduced to 2 per cent by the end of 2012, whichalso applied to the 2012 loan.




http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/People_at_risk_of_poverty_or_social_exclusion

http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/People_at_risk_of_poverty_or_social_exclusion

Private sector debt has also risen, from 101 per cent of GDP in 2007 to 136 per centin 2013.22 The pressure the private sector finds itself under is further evidenced fromthe high ratio of non-performing loans (NPL) to GDP.23 For example, betweenQ42008 and Q32013, the ratio of NPL to total gross loans increased from 4.7 percent to 31 per cent. This was the highest ratio amongst the eurozone member states.24

Financial liabilities

De Grauwe has argued that the fiscal profligacy narrative and the ensuing austeritypolicy in the eurozone are fighting the ‘wrong enemy’ (De Grauwe 2010). This istrue also of Greece, in spite of its chronically high public deficit and debt. Asshown in Figure 6, prior to the financial crisis the ratio of corporate (both financialand non-financial) debt to GDP exceeded that of the public sector, while householddebt was also on the rise. It is only after the start of the crisis that public liabilities over-took private ones, with the exception of the financial sector, whose debt continued itsupward climb, reflecting the weakening of the economy and the sector’s increasingfragility.

Overall, the public debt of Greece remains unsustainable largely due to the debt-deflation dynamics triggered by the economic crisis and amplified by the Troika pre-scription. Indeed, Papadimitriou et al. have concluded that:

The current economic conditions in Greece are, by and large, the result of foolish policybased on a shaky economic theory that advocates ‘expansionary austerity,’ along withlabor market reforms, as the best recipe for medium- and long-term growth in countriesthat like Greece are running large government deficits and high levels of public debt as apercentage of GDP. (Papadimitriou et al. 2013, p. 2)

350.0300.0250.0200.0150.0100.050.00.0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Non-financial corporations Financial corporations General governmentHouseholds; non-profit institutions serving households


Figure 6 Debt by sector as a percentage of GDP

22. Where the private sector debt is the stock of liabilities (Debt securities and Loans at the endof the year) held by Non-Financial corporations and Households and Non-Profit institutionsserving households.23. A loan is non-performing when payments of interest and principal are past due by 90 daysor more, in accordance with the Basel II definition of default.24. http://www.oecd-ilibrary.org/economics.




http://www.oecd-ilibrary.org/economics

4 EPILOGUE

The roots of the public debt crisis in Greece go beyond the domestic factors accountingfor its high public and current-account deficits. They encompass the narrow outlook ofEU policy, which at a time of crisis became highly pro-cyclical, and the role of globalfinance, of which European finance is an integral part, both in deflecting the pressuresfor financial policy reform and in shaping economic policy.

Starting in late 2009, the management of the public debt crisis, both by theEuropean and the Greek elites, plunged the economy and large sections of the popul-ation into an unprecedented crisis by the standards of a European democracy at a timeof peace. This bears many of the characteristics of a debt-deflation depression with theattendant economic and social implications. As Floyd Norris (2013) has observed,‘Seen from Greece, the Great Depression looks good’!

Starting from a high debt level, the Greek economy went through disinflation anddeflation, contraction of consumption and investment, distress selling and a fall inasset prices, bankruptcies and a decline in output and employment, while exportsdid not provide any counter-stimulus. The money supply contracted, as did bankcredit.

Five years into the crisis (2009–2014), Greece finds itself in a deflationary process.The prevailing EU policy view supports fiscal austerity and market deregulation as theway out of the crisis. We have argued that this view is based on a theoretical miscon-ception of the crisis, largely explained by an ideological bias against inflation.

The Greek case serves as an illustration of the failure of the current economic andpolitical orthodoxy in the EU. As the recession deepens, morphing into a depression,the outlook for Greece is particularly uncertain. Its eurozone partners seem prepared toprovide more concessions in order to keep it in the monetary union, on condition that itcontinues to apply the Troika prescription. The majority of the Greek people, however,are exhausted by these policies. There have been signs of fascism raising its ugly headin Greece. These have temporarily been stemmed, although in no way eradicated.

The result of the national elections on 25 January 2015 bear witness to the searchfor an alternative route out of the crisis, a route that makes economic sense and allowsthe Greek people to maintain their dignity as a democratic polity. SYRIZA (acronymfor Coalition of the Radical Left) won 36.34 per cent of the vote, thus forming agovernment in coalition with the Independent Greeks (ANEL, a centre-right party).SYRIZA’s electoral programme prioritized dealing with the humanitarian crisis andundertaking deeply needed reforms, such as eradicating tax evasion and corruption.With regard to the country’s mounting public debt, the SYRIZA-led governmentseeks a solution that will provide some room for fiscal manoeuvre aiming at stimulat-ing the economy and setting it on the path of growth.

So, what is to be done? At the time of writing, the SYRIZA-led government repre-sentatives are trying to convince their eurozone partners that the Economic AdjustmentProgramme of Greece needs to be revised, so as to allow the country to change courseand in so doing to reduce its debt. They are also referring to the precedent of the LondonDebt Agreement of 1953, which forgave the largest part of the debt of Germany, bothprivate and public, incurred in the interwar years and after the Second World War.

These are difficult negotiations insofar as the Greek government is effectively ques-tioning the very edifice on which the present EU orthodoxy is based. In spite of theprofessed desire of Germany and other eurozone partners to avoid Greece’s departurefrom the European Monetary Union, such an ‘accident’ cannot be precluded. In fact,SYRIZA’s programme does include such a possibility as a last resort. Damaging as




such an outcome would be for both sides, it may eventually be the only way out of thepresent impasse.

While the Greek plight does not seem to have influenced EU policy-making so far,the prospect of deflation taking hold of the eurozone seems to be worrying financialanalysts, journalists and politicians alike. Quantitative easing, the ECB’s ‘bazooka’,is set against a background of a persistently falling inflation rate in the eurozone,which averaged 0.17 per cent in December 2014 by comparison to 0.85 per cent inDecember 2013 and 2.22 per cent in December 2012. Although such a measuregoes in the direction of easing some of the pressure on the economy, historical experi-ence teaches us that it cannot alone deal with the prospect of deflation. It needs to bematched with fiscal policy, above and beyond the theoretical, ideological and politicalconstraints of eurozone austerity policy.

Furthermore, in a long-run perspective, both the EU and its member states need toadopt policies for the restructuring of their productive sectors, not through further lib-eralization, but through carefully targeted actions for a socially and environmentallysustainable pattern of development.

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De Grauwe, P. (2010), ‘Fighting the wrong enemy’, VOX, 19 May.European Commission (2012), European Financial Stability and Integration Report.European Commission (2013), ‘A recovery on the horizon?’ Annual Report on European SMEs

2012/2013.European Commission (2014), ‘European Economic Forecast: Autumn 2014’, European Econ-

omy 7/2014.Fisher, I. (1933), ‘The debt-deflation theory of great depressions’, Econometrica, 1(4), 337–357.Frangakis, M. (2006), ‘Integrated guidelines for growth and jobs, 2005–2008: a shift in EU

economic policy?’, European Journal of Economics and Economic Policies: Intervention,3(1), 59–75.

Frangakis, M. (2011), ‘The public debt crisis in Greece – roots, policies, outlook and alterna-tives’, http://www.tni.org/article/public-debt-crisis-greece.

Gibson, H.D., S.G. Hall and G.S. Tavlas (2011), ‘The Greek financial crisis – growing imbal-ances and sovereign spreads’, Bank of Greece, WP 124, March.

Grahl, J. (ed.) (2009), Global Finance and Social Europe, Cheltenham, UK and Northampton,MA: Edward Elgar.

IMF (2013), Country Report 13/156, June.INE-GSEE (Labour Institute of the Confederation of Greek Workers) (2013), Annual Report (in

Greek).Kalecki,M. (1943), ‘Political aspects of full employment’, The Political Quarterly, 14(4), 322–331.Keynes, J.M. (1930 [2008]), ‘The great slump of 1930’, The Nation & Athenaeum, London, 20

and 27 December, reprinted as an eBook by A Project Gutenberg Canada eBook, 2008,November.

Keynes, J.M. (1936 [2003]), ‘Interest and money’, The General Theory of Employment, Interestand Money, reprinted as an eBook by A Project Gutenberg Australia eBook, 2003, February.

Norris, F. (2013), ‘Seen from Greece, the Great Depression looks good’, The New York Times,16 March.

OECD (2014a), ‘Greece’, Society at a Glance.OECD (2014b), ‘Income inequality update, rising inequality: youth and poor fall further

behind’, June.Palley, T., L.-P. Rochon and M. Vernengo (2012), ‘Statement of the co-editors: economics

and the economic crisis – the case for change’, Review of Keynesian Economics, InauguralIssue, 1–4.




Papadimitriou, D.B., M. Nikiforos and G. Zezza (2013), ‘The Greek economic crisis and theexperience of austerity: a strategic analysis’, Levy Institute of Bard College, Strategic Ana-lysis series, July.

Schauble, W. (2011), ‘Why austerity is only cure for the Eurozone’, Financial Times,5 September.

Schiaffino, P. (2013), ‘A comment on the ECB solution vs the Keynes solution’, Journal of PostKeynesian Economics, 35(3), 457–462.

Stathakis, G. (2010), ‘The fiscal crisis of the Greek economy’, Paper presented at the IIPPEConference, September.

Stockhammer, E. (2012), ‘Euro-Keynesianism? The financial crisis in Europe’, RadicalPhilosophy, 175, 2–10.

Zettelmeyer, J., Ch. Trebesch and M. Gulati (2013), ‘The Greek debt restructuring – an autopsy’,Peterson Institute for International Economics, WP 13-8, August.




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